Perfect Competition

Perfect Competition (Review)

• What is Perfect Competition?
• Profit Maximization by a Price-Taking Firm
• Functional Forms
• Revealed Profitability
• Supply Curve of a Firm

Perfectly Competitive Markets

• A perfectly competitive market consists of firms that produce identical products that sell at the same price

• Each firm’s volume of output is so small in comparison to the overall market demand that no single firm has an impact on the market price

Perfectly Competitive Markets - Conditions

1. The industry is fragmented
   • It consists of many buyers and sellers
2. Firms produce undifferentiated products
   • Consumers perceive the products to be identical no matter who produces them

Perfectly Competitive Markets - Conditions

3. Consumers have perfect information about prices
   • The industry is characterized by equal access to resources
4. All firms —incumbents and prospective entrants— have access to the same technology and inputs

Implications of Conditions

• The first characteristic implies that sellers and buyers act as price-takers

• The second and third characteristics imply a law of one price

• The fourth characteristic implies that the industry is characterized by free entry

The Profit Maximization Hypothesis

\[ \begin{align} \max_{Q} \pi(Q)&=TR(Q)-TC(Q) \\ \text{s.t. } Q&\ge0 \end{align} \qquad(1)\]

• Economic Profit = Sales Revenue - Economic (Opportunity) Cost

• firm sells output Q; TR(Q), revenue from selling the quantity; TC(Q), economic cost of producing the quantity Q

The Profit Maximization Condition Continued

• The profit maximization condition is

\[ \frac{dTR(Q)}{dQ}= \frac{dTC(Q)}{dQ} \]

• Marginal revenue equals marginal cost

Functional Forms

• We can define our problem in several ways depending on the question we’re interested in

1. Output quantities: \(TR(Q)=PQ\) and \(TC(Q)\)

2. Input quantities: \(TR(K,L)=Pf(K,L)\) and \(TC(K,L)=rK+wL\)

Graphs

Conditions for an interior optimum

• \(\frac{dTC(Q)}{Q}\) should be increasing

• \(\frac{df(\bar K,L)}{dL}\) should be decreasing

Revealed Profitability

Supply Curve of a firm

Review Questions

• Productivity

• Carbon tax